Develop an ETF “They May Never Completely Quit QE” Buy List

by Gary Gordon | December 17, 2013 9:30 am

Emerging market ETFs are pulling back sharply from gains that they had achieved in recent months. The countries with the largest drops in the past few days are those that are most dependent on foreign capital to finance their super-sized deficits.

In essence, speculation that some of the world’s central banks may pare back the printing of money is adversely affecting funds like WisdomTree India Earnings (EPI[1]) and iShares MSCI South Africa (EZA[2]). The broader-based Vanguard Emerging Markets (VWO[3]) is not faring particularly well either.

Indeed, more and more investors are beginning to fret that the Fed will reduce its $85 billion per month bond-buying program.

From my vantage point, the shorter-term speculation will fizzle out. The near-term concern that the Fed may curb its enthusiasm for electronic money creation does not alter the longer-term trend of extremely slow growth across the world’s developed economies. Europe, Japan, and yes, the U.S. — expansion in developed regions is extraordinarily fragile. It follows that central banks around the globe are unlikely to tighten the reins in a meaningful manner and risk soaring yields that would adversely affect their ability to pay the interest on massive debts.

What does it all mean? It means that cheap money via “QE” is going to be around for many years to come. It also means that any effort to wind down emergency stimulus will be abandoned at the first sight of recessionary struggles. Keep in mind, in every instance over the last five years where the Federal Reserve attempted to curtail a QE program, they started another. It follows that the investment community will continue viewing stock setbacks as opportunities (e.g., “buying the dips”), at least until the day when investors lose confidence in central bank stimulus.

My suggestion? Use near-term sell-offs to fill gaps in your current allocation with ETFs that thrive on central bank stimulus bounces. The most recent and best example of this phenomenon is the one that occurred when Bernanke’s Fed decided not to put the brakes on its $85 billion per month this past September. The market had to contend with a government shutdown, but once investors were able to buy the dips on shutdown concerns, stock assets were off to the races.

Here are some of the ETFs that performed exceptionally well over the previous 10 weeks:

ETFs To Consider For The Reality That Any Tapering Will Be Tiny

Approx 10 Wks

iShares DJ Aerospace (ITA)

11.0%

SPDR KBW Regional Banking (KRE)

10.2%

S&P SPDR Pharmaceuticals (XPH)

10.1%

iShares DJ Transportation (IYT)

7.7%

PowerShares Dynamic Industrials (PRN)

7.6%

S&P 500 SPDR Trust (SPY)

6.5%

Perhaps ironically, a number of relative strength outperformers are the same ones that have been less affected by the possibility of tapering one way or another. These include defensive assets that are less tied to business cycles such as aerospace and pharmaceuticals. For these sectors — segments that I have recommended throughout 2013 — performance chasers may simply be “dressing the windows” for clients. Momentum is still likely to carry them further, but make certain to have your sell discipline intact should lofty valuations tempt profit-takers early in 2014.

The run-up in transportation stocks, regional banking shares as well as industrials tell a different story. Mainly, energy prices have dipped and the Fed will likely succeed in its quest to keep interest rates in check.

Granted, some folks will tell you not to fear the “taper” because they believe the U.S. economy is close to sustaining itself without emergency level stimulus. I’m not one of those folks. On the contrary, most of the economic growth can be directly tied to Fed intervention and any genuine move away from the rate manipulation would likely stoke recessionary flames.

That said, I do not believe our central bank or others around the world are willing to let their economies sink or swim on their own. The answer the developed world has come up with is to continue printing money electronically. Stock market corrections notwithstanding, the trend higher is likely to remain until the world’s investors begin to lose faith in the very notion of QE intervention.

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